The Case of Disappearing “Cash Flow” and New Red Flags in the WeWork IPO

Under heavy fire from Wall Street, WeWork parent We Co. has made some serious tweaks to its planned IPO. It’s added a female board director, CEO Adam Neumann returned a few million dollars for a questionable trademark, and the offer price has reportedly been slashed. But there’s another change to the latest offering document that investors should examine with care: Far fewer mentions of some important terms like “break-even,” “profitable” and “cash flow.”

The words “cash flow” and “cash flows” were mentioned a combined 148 times in the original S-1 filing but only 126 times in the September 3 version, according to a document comparison using Sentieo, which provides a redlining function to examine changes in documents such as SEC filings. The change is unusual: Recent IPO filer SmileDirectClub reduced the count to 41 vs. 42 while Cloudflare held steady at 57 vs 57.

“The changes, in our view, are remarkable both in terms of materiality and direction,” said Nick Mazing, Director of Research at Sentieo. “Given the extensive involvement by legal teams and executives in SEC filings, readers should assume that all changes are material.”

How exactly might these changes matter? Consider a portion of the prospectus where WeWork explains how its workspace-sharing locations can generate money. The company, which incurs steep net losses and has a negative Ebitda margin of roughly 37%, originally said “After an initial investment, each additional location not only adds members to our platform and revenue to our income statement, but also becomes profitable once it reaches a break-even point.”

That sentence may have exaggerated how quickly locations can become profit drivers. In the latest prospectus, WeWork words things more cautiously: “Once a location has been open to members for more than 24 months, occupancy is generally stable and the location typically generates a recurring stream of revenue that covers our location operating expenses and contributes to the recoupment of our initial investment in the location.”

Such a distinction could be highly significant. Even if locations can cover their expenses after two years, there are far more costs at the corporate level. In 2018, location expenses were $1.5 billion but other expenses were $2 billion. The latter include such items as salaries for senior executives and the more-than 1,000 engineers, product designers and machine learning scientists who work at the company.

WeWork also added a warning about a weaker second half of 2019. “We currently expect our contribution margin percentage to decline slightly in the second half of 2019 relative to the first half of 2019 due to an increase in the percentage of our locations in developing markets, including China, and an increase in member technology expenses as we continue to invest in improving our overall member experience,” the updated filing says.

That trend could extend beyond this year. The new filing also added the phrasing: “average revenue per WeWork membership has declined, and could continue to decline if we expand into lower-priced markets.”

Another concerning change was a decision to no longer disclose committed revenue from members. The following sentences were removed: “This creates a backlog of committed revenue, which we expect will drive increasing recurring revenues and cash flows as well as increase our revenue visibility. We had committed revenue backlog of $4.0 billion as of June 30, 2019, approximately eight times the $0.5 billion as of December 31, 2017.”

All of these tweaks could impact the company’s path to profitably and how Wall Street tries to model it. As the likes of Uber and Lyft have shown, investors are unwilling to make big bets on profits that may not come for several years, especially when they lack a decent roadmap. What’s more, investors have noted CEO Adam Neumann’s potentially excessive voting control, related-party dealings, and weak corporate governance.

With WeWork’s IPO possibly pricing in the next couple of weeks, the pressure will be on the company and its lead investment bankers at The Goldman Sachs Group, Inc. and JPMorgan Chase & Co. to put on quite a performance.